A person's credit history is a complicated record of their experience with debt. When people try to buy a home, they often use their credit report and score to qualify for a mortgage to pay for the sale. With these tips, potential borrowers will understand how credit reports and scores affect the home buying process.
Credit Report vs Credit Score
Although lenders usually look at a person's detailed credit history as well as their credit scores, there is a practical reason to understand the difference. A credit report is a listing of a person's current and recent debts and payments to various creditors. Credit reports may also contain information about unpaid accounts that went to collections, or other uncommon forms of debt. The credit score takes this information and assigns a number based on the common features of a person's credit report. There are three credit reporting agencies, and sometimes creditors do not report to all three of them. As such, the report and score for one agency may be significantly different than the report and score for another.
Preferred Credit Score Ranges
Each person has a credit score that places them on a spectrum from 300–850 points. Higher scores generally indicate that a person has a more reliable credit history, and can be considered a better borrower for potential mortgage lenders. The credit reporting agencies typically break down the scores into five classifications:
Having a poor or even fair credit score does not necessarily disqualify an applicant from getting a mortgage. Although most lenders prefer candidates to have a credit score of at least 660, some government-backed mortgage programs (e.g. FHA loans) will consider borrowers with a credit score of 500 or higher. Some lenders will take the median score of the three, while others only consider the lowest score for loan eligibility.
Negative Credit Information
Lenders look most harshly on what are known as “credit events.” A credit event indicates that something about a person's credit history has changed, usually for the worse. The event might be as simple as a single late payment to a credit card, or as significant as a foreclosed home or a bankruptcy. Lenders pay special attention to these factors because it indicates how an applicant is likely to repay the mortgage if their financial circumstances change. Lenders watch a person's report during the entire buying process, and may rescind a loan offer if an applicant's credit status changes.
Negative information can stay on a person's credit report for years and affect their credit scores for a long time. Most minor negative incidents will last at least two years before they drop off the report, but they may remain longer. Foreclosures and bankruptcies often stay on the credit history for 7–10 years. Any negative information on a person's credit history may render them ineligible for a mortgage, or cause the lender to request a detailed explanation.
Getting the Best Terms
For people with good or excellent credit, the distinction in their credit report and credit scores might just relate to the kinds of terms a mortgage lender chooses to offer them. People with the highest scores usually get the best mortgage interest rates, options for a low down payment, minimal requirements for assets in reserve, and more choices in the types of loans they might consider. Small changes in credit score could make a notable difference. A person with a credit score of 720 might not get loan offers with terms as favorable as someone with a credit score of 740 or 760.
How Your Credit Score Impacts Your Mortgage Rate
A credit score is a critical component in determining not only if a borrower is qualified to get a mortgage loan, but how much interest they will pay on the loan. The better the credit rating (higher the score) the more faith the lender can have in the full repayment of the loan and the lower interest rate they may offer. Those with poorer credit (a lower score) may have to pay significantly higher interest rates.
Consumers are considered to have good credit if their credit score is between 670 and 739. A credit score of 740-799 is considered “very good” and 800-850 “exceptional”. Those with a credit score 580-699 is thought to have “fair” credit and 300-579 is considered “poor”.
If the difference between a mortgage interest rate with fair credit and excellent credit is just 1%, it stills makes a major impact. For example, the total cost of a mortgage of $200,000 paid over 20 years at 4% would be about $290,000. That same loan at 5% would cost a consumer about $316,000, a difference of over $26,000.
How Can a Consumer Improve Their Credit Score?
The first step is to get and stay current with all present payments. You may want to reduce debt by paying off smaller debts and those with higher interest rates first. Consumers should avoid a major purchase or opening up additional lines of credit when actively trying to improve a credit score. Creditworthiness can also be improved by increasing income.
Planning ahead gives consumers time to check their credit, report any errors, correct those errors, and work on improving a credit score. A credit score can also impact the amount of a deposit a borrower may require on a home. Checking, building and maintaining good credit can save thousands of dollars when buying a home.
Correcting Errors on Credit Reports
Since the data on a person's credit report affects their score so much and is examined so closely by lenders, accuracy in the report is paramount. A mistake that records an on-time payment as late could decrease an applicant's score by several points. This could restrict the kinds of loan terms they could get in a mortgage, or even prevent them from qualifying at all. Financial experts suggest that people get a copy of all three of their credit reports at least a few months before they plan to buy a home. If there are any errors, they should write to the reporting agencies with proof of the problem, so that the issue can be corrected. This way, they have an accurate credit report for their mortgage applications.
Buying a home does not require perfect credit, but a person's credit history and credit scores are still very important to the process. With careful attention to their credit reports before they apply for a mortgage, interested West Calgary home buyers can better ensure that they avoid unpleasant surprises.